THE meltdown in high-flying technology stocks like Facebook is just the start of the financial changes that will probably result from the Federal Reserve’s decision to end a prolonged era of free money, and make borrowing more expensive.
With the Fed signalling that higher interest rates are coming next month, investors have begun shedding some of their priciest stocks in favour of bets on companies poised to prosper as the economy adjusts.
The Fed over the past two years helped insulate the US economy from the worst effects of the Covid-19 pandemic by flooding markets with cash. Holding its benchmark lending rate near zero, and purchasing nearly $5 trillion (R77.3 trillion) in mortgage-backed and government securities helped drive prices higher on all kinds of assets: stocks, bonds, cryptocurrencies and housing.
Few companies benefited from this heady run more than the titans of Silicon Valley, which saw their share prices swell almost beyond reason as Americans turned to their products to survive the pandemic.
That bubble, for some firms, may be popping.
With the economy now on solid ground – delivering a robust 467 000 new jobs in January – the Fed is preparing to withdraw its emergency support and focus on cooling off the highest inflation since 1982. That shift to higher interest rates is prompting investors to rethink their strategies and scrutinise companies more closely. The results were evident on Friday, as Amazon rocketed to the largest single-day gain in value in stock market history 24 hours after Facebook’s parent company Meta suffered its greatest one-day loss.
“The market has been very comfortable ignoring valuations on the things that have delivered growth through the pandemic… It feels like the world is entering a different environment than the one we’ve been in,” said Roger McNamee, co-founder of Elevation Partners, a private equity firm in Menlo Park, California. “The pricing of risk is changing.”
The Fed’s easy money stance helped fuel an extraordinary bull market in stocks. From its pandemic low in March, 2020 to the beginning of last month, the Dow Jones industrial average roughly doubled in value.
Both the Fed and the International Monetary Fund warned in recent months that stock prices could be losing touch with their fundamental values. Relative to earnings forecasts, prices were at “the upper end” of historical experience, the Fed said in November, adding: “Asset prices may be vulnerable to significant declines should risk appetite fall.”
Higher interest rates hurt companies with lofty stock prices based on the expectation of dramatic earnings growth years in the future, such as the hi-tech favourites that dazzled Wall Street over the past two years. As rates rise from near zero, alternatives to stocks eventually will become more attractive.
“If your cost of money is zero, why not take a flier on anything? But if your cost of money is 10 percent, you’re going to be pretty picky with what you in invest in because you need to make more than a 10 percent return," said Richard Bernstein, a New York-based investment manager.
Still, investors show no signs of abandoning the stock market or tech stocks in general. On Friday, following Facebook’s historic plummet one day earlier, Amazon shares jumped by more than 15 percent after the company reported that its quarterly profit had doubled.
Demonstrating the ability to raise prices that investors see as a sign of a strong company, Amazon said it is hiking the price of an annual Prime membership to $139 from $119, the first increase since 2018. (Amazon founder Jeff Bezos owns The Washington Post.)
Tech stocks peaked late last year as it became apparent that the Fed was growing more worried about the inflation outlook. As investor concerns about the Fed’s rate-hike plans grew, the Big Tech stocks that have accounted for most of the stock market’s gains in recent years were the first to feel the pain. January was the worst month since 2008 for the Nasdaq Composite Index, which is heavily weighted towards tech companies. Amazon shares fell around 10 percent, Microsoft lost 8 percent, Google and Facebook dropped around 7 percent, and Apple dipped by 2 percent.
So far this year, the tech-rich Nasdaq Index is down about 10 percent.
Facebook suffered the biggest impact, with its stock falling 26 percent on Thursday, erasing more than $230 billion in value. Adjusted for inflation, that's equal to the entire stock market's loss on Black Tuesday in October 1929.
Facebook’s particular weaknesses – including flatlining user numbers – left it especially vulnerable to the shift in investor thinking. But it won’t be the last casualty as the financial climate changes.
Fed Chair Jerome Powell hopes to engineer a “soft landing” for the economy, cooling activity just enough to take the steam out of rising prices, while preserving sufficient strength to keep jobs abundant and profits high. It’s a goal that has often eluded previous Fed chiefs and some on Wall Street are sceptical that the economy can avoid an unwanted downturn.
“Having witnessed the Fed’s big mischaracterisation of inflation for most of 2021, concern is mounting that it will now make a second policy mistake – that of pivoting hard from policy inaction to being forced into a bunch of measures that will damage the much-needed inclusive economic recovery,” Mohamed El-Erian, chief economic adviser at Allianz, said via email. “Very few asset classes are immune to a twin blow of a Fed policy mistake, and patchy market liquidity.”
Markets are pricing in several quarter-percentage-point increases in the Fed's benchmark rate this year. Just the prospect of Fed tightening has rattled bond markets, sending the rate on a 30-year fixed mortgage to 3.84 percent on Friday from 3.27 percent at the end of last year.
The pandemic has been good for the stars of the Internet Age.
Trapped at home, Americans shopped on Amazon, worked via Zoom and amused themselves playing video games and binge-watching Netflix.
But amid signs that the Omicron variant has peaked in much of the nation, the massive growth internet companies enjoyed over the past two years is levelling off. The high-growth bar investors had set for companies has become harder to meet. In recent days, several fell short in a big way, wiping hundreds of billions of dollars off the stock market.
The collapse in Facebook’s value came after it surprised investors with news of its first-ever drop in the number of daily users and a glum revenue forecast. Restrictions on how it could track users on Apple iPhones for the purpose of showing them ads are expected to cost Facebook $10 billion this year.
Chief financial officer David Wehner said the number of ads it was able to show consumers dropped 6 percent in North America from the same time last year. The company’s target audience is spending more time on apps like TikTok and less on Instagram and Facebook.
“Facebook is just facing this perfect storm of hits right now,” said Mark Mahaney, senior managing director at Evercore ISI.
Facebook’s problems will not go away any time soon. TikTok, with over a billion users, has become an online fixture. American teens are more likely to log into the Chinese-owned social networking service than Facebook’s Instagram and say the newer app’s videos are funnier and more positive, according to a November 2021 Forrester Research study.
Other tech companies have contributed to the stock market’s sell-off. Payments company PayPal saw its shares fall 24 percent on Wednesday – its biggest one-day fall – after reporting earnings, and telling investors it was abandoning a plan to double its customer totals.
Audio company Spotify, which is grappling with a crisis surrounding its biggest podcaster Joe Rogan, also said growth would slow. Its shares fell 17 percent. Netflix shares have fallen over 30 percent in the past month, after missing analyst customer forecasts. Executives blamed increased competition from streaming services like those offered by Apple and Disney.
It’s not that investors have soured on all tech stocks. But rather than throw money at the entire sector, they are growing more selective.
Google, Amazon, Apple and Microsoft all posted positive earnings results and anticipate continued growth. While Facebook is suffering from Apple’s ad-tracking changes, Google is benefiting, as advertisers switch to its search and YouTube businesses. Amazon’s $31bn annual ad business grew 30 percent in the past year, and its cloud computing business is booming.
“What’s come shining through in this earnings season is the highest quality big tech names, Microsoft, Apple, Amazon and Google came through with flying colours despite all the fears,” Mahaney said.
Even the good companies will be facing a turbulent period.
Fed tightening historically has been bad news for stocks, according to Morgan Stanley. During this cycle, with the Fed pulling back on providing funds for the financial system – what investors call liquidity – share prices overall are probably going to lose ground, the firm said in a recent research note.
“The liquidity provided allowed people to make much more speculative bets because the Fed safety net was there,” said Liz Young, head of investment strategy at SoFi. “That is now gone.”
Investors are redirecting their bets to banks, energy producers and makers of consumer staples, which boast strong current sales, rather than hopes for future growth.
The Fed has tried before to wean the economy from extraordinary support, but buckled in the face of a market outcry or economic weakness. In 2015, the central bank began lifting its key rate from zero. Less than four years later, as the US trade war with China took a toll on growth, it was forced to reverse course.
The difference this time is that 7 percent annual inflation leaves Powell no choice but to follow through, even if investors scream, said Ed Yardeni, a prominent investment strategist with Yardeni Research.
“It’s a major U-turn,” he said. “For all practical purposes, we’ve had ultra-easy monetary policy since 2008. This time, they won’t back off, no matter what.”
The Washington Post